Tuesday, August 27, 2013

The Wall Street Journal reported yesterday that many of China's overseas investments in mining assets have turned out to be expensive boondoggles. "China Rethinks Deals for Resources" uses the example of a huge $8-billion Australian mine that has never exported a single chunk of ore to illustrate a pattern of expensive, unproductive Chinese investments in mining assets around the world.

According to the article, "China has plowed $226.1 billion into outbound mergers and acquisitions to grab a slice of global resources since 1995." The article says about a quarter of that investment was in mining. Several multi-billion dollar projects have been shelved lately. These projects have been hit by everything from soaring labor costs to a giant grinding mill that doesn't work, discovery that ore is laced with asbestos, and mines in the middle of nowhere with no infrastructure.

According to a Chinese iron ore industry official quoted by WSJ, "The problems don't mean Beijing will stop China's overseas push for global ore assets, underlining the country's need to 'break a global monopoly.'"

The article does not mention agricultural projects. They are probably much smaller in dollar value in comparison with the mining projects, but very similar in principle. As the WSJ article notes, the mining investments by giant Chinese state-owned companies are designed to buy global market share in an industry dominated by multinational titans. The Chinese companies, bank officials who fund the projects, and government officials who give the orders to go ahead with them are operating under the mistaken assumption that "big" equals "profitable." They worry that big multinationals are going to take advantage of Chinese buyers by "monopolizing" commodities. Driven by their paranoia, Chinese companies and banks instead burn through billions of dollars in unproductive overseas investments in ill-considered projects.

According to WSJ, imports from China-controlled iron ore mines account for just 2.7 percent of China's iron ore imports, far below the 40-percent target set in 2011. Agricultural projects likewise account for a negligible share of Chinese food imports. Of course, it takes a while for farms to become productive, but there is no reason to think that Chinese companies investing in South America or Africa would be any better at growing soybeans and corn in an unfamiliar land than they are at mining.

Chinese state-owned companies are propped up in their domestic market by subsidies, sweetheart deals where they can buy low and sell high, free real estate, bottomless bank loans, and preferential access to IPOs. Why would anyone expect these companies accustomed to wasting resources at home to do anything besides waste money on massive ill-considered projects when they invest overseas?

Monday, August 26, 2013

Chinese pork prices have moved above their break-even level after 3-to-4 months of deep losses. But an industry commentary on August 24 suggests that another cyclical downturn may already be on the horizon because profits never last long in the Chinese pork sector.

A build-up of capacity in 2012 (following high prices in 2011) led to a glut of pork in 2013. The generally slow economy, orders to cut back on official banqueting, and a brief bout of consumer disgust stimulated by thousands of dead pigs floating in Shanghai's Songjiang River curbed demand. The result was a dip in prices and steep losses from February through June this year. A farmer in Shandong said he lost 60 yuan (about $10) on every pig he raised from April to June. In July, pig prices rose above their breakeven level of six times the corn price and now the farmer is making 14 yuan per head.

The pork industry is now heading into the peak consumption season when school cafeterias start serving pork again and two holidays take place around October 1. However, some commentators warn producers not to get too optimistic. The industry still has a lot of capacity because few farmers liquidated sows during the down period. A number of pork companies have launched big projects recently too.

One industry analyst warns that the industry needs to recover the losses from the last few months before getting excited about a rosy scenario. Analysts warn that the hog industry is inherently weak and vulnerable. It's an industry of micro profits.

This is a reminder that a big industry is not necessarily a profitable one. A decade ago, a number of multinational investment banks piled into the Chinese pork industry, presumably based on the idea that the industry was a sure money-maker since Chinese people will eat more pork as they get richer. In July, Shenzhen's Yangcheng Evening News speculated that the Shuanghui Company's purchase of Smithfield was in reality a mechanism for big investment banks with stakes in Chinese pork companies to cut their losses and exit the volatile industry.

One Chinese analyst quoted in the Yangcheng Evening News explained the pork industry as follows: "I'm not optimistic about the massive inflow of capital. Some problems need time to solve; capital can't solve them." During the time of rising prices, said the analyst, foreign capital entered the industry but soon met a downturn. The analyst suggested that a large investment bank with stakes in both Shuanghui and Smithfield was using the deal to "cash out" of the Chinese industry after its years of baptism.

Wednesday, August 21, 2013

A Chinese news magazine reported this week that 110 managers of grain depots in Henan Province have been ensnared in corruption probes. Operators of local grain warehouses routinely paid bribes to superiors who turned a blind eye to subsidies paid for nonexistent grain reserves and embezzlement of funds for warehouse construction. The behavior uncovered in the probes has been going on for years, and the revelations about these "big rats" in official media appear to be part of this year's broader crackdown on corrupt officials pushed by new President Xi Jinping.

According to news magazine Liaowang, the investigation was kicked off in 2011 when the head of the Zhoukou, Henan branch of Sinograin--China's reserve management company--fled the country with more than 300 million yuan in pilfered funds. Investigations found a chain of corruption from local depots to the head of Sinograin's Henan Province branch. The general manager of the Henan had a mafia-type operation, collecting routine bribes from a network of local depot managers amounting to 14 million yuan plus 8.9 million yuan of property he couldn't account for. The general director was sentence to life imprisonment and his wife and mistress got 7 and 8 years, respectively.

The Henan general director was accused of regularly taking bribes from 65 people. One depot director explained, “He had power over promotions, transfers, fund disbursements, so 'holiday fees' became commonplace." The bribes started out at 3000-5000 yuan each several years ago but grew to 10,000 yuan last year. One depot director reportedly paid 23 bribes totaling 1.9 million yuan. One level down, the depot managers also took bribes from their underlings.

One technique for stealing funds is to collect subsidies for holding grain purchased for government reserves to support prices. Each metric ton can bring in a 50-yuan purchase fee, 86 yuan in storage fees, 30 yuan for expenses of rotating grain, and a differential between purchase and sale prices. The same grain is sometimes sold in multiple transactions, a practice known as "circular grain" or "round-tripping." Numerous private traders paid bribes to gain approval as purchasers of market intervention grain.

Some dealers and depot managers colluded to create fake purchases. Investigators found forged purchase documents and farmer ID cards used in the illicit transactions.

According to Sinograin accounts, 80 percent of Henan's wheat was purchased by Sinograin depots in 2009 and 2010. It is estimated that actually less than half of the wheat was purchased. Liaowang reports estimates that no less than one-sixth of the grain reserves in Henan are "round-tripped" through such fake transactions.

Another strategy is to embezzle funds for construction or equipment purchases. Some grain warehouses were built in a shoddy manner, were nonexistent, or sold to Sinograin at excessive prices. Depot managers pocketed the extra funds.

The Liaowang article blames the problem on lack of oversight and a "hills are high and the emperor is far away" attitude. The central Sinograin headquarters and its provincial branches are a separate legal entity from the local depots. Sinograin has little vertical control over local managers and only half-heartedly looked into reports of problems or turned a blind eye. Beijing Sinograin officials generally only wrote checks and came to inspect well-run model depots. Personnel are posted in the same location for many years and develop relationships with local traders and others with little supervision from above, creating "dens of thieves."

Described as a "typical" case, the director of the Zhoukou depot embezzled hundreds of millions of yuan during his ten-year tenure. He made dozens of trips abroad, misused passports and used funds to make investments in the United States in order to facilitate emigration of his wife and child.

These revelations concern only one of China's 31 provinces. In May there was a suspicious fire at a grain reserve depot in Heilongjiang that burned up thousands of tons of grain. The timing of the fire was suspicious because investigators had just arrived to look into misallocations of funds.

A former grain bureau director interviewed by Liaowang praised the grain market intervention policies for their great achievements in stabilizing markets. But he also called the den of thieves in Henan a painful lesson that calls for better management and organization. However, it seems inevitable that putting people in control of large amounts of other peoples' money with little or no accountability will inevitably lead to corruption and abuse.

Wednesday, August 14, 2013

Chinese authorities appear to have accepted the fact that their country will be a corn importer for the foreseeable future. Now they're nervous about their reliance on the U.S. for nearly all of their corn imports, and they are trying to find competitors for the Americans.

According to Rural Commercial News, Argentina's agriculture minister announced that a 60,000 metric ton shipment of corn from his country has been approved for import by Chinese authorities. The corn reportedly has been shipped to inland areas of China where it will be used for pig and poultry feed. According to "news," China is expected to buy 500,000 metric tons of Argentine corn this year.

Grain analyst Chen Changxiu describes the prospect of Argentine shipments as signaling the end of American dominance of the Chinese corn import business. The article says Argentina is the second-largest corn exporter and the chief competitor of the United States. It says Argentina gives China an alternative to U.S. corn. Mr. Chen says Argentine corn is cheaper than U.S. corn for Chinese importers and poses a challenge to the dominance of U.S. exporters. In 2012, China agreed to accept corn from Ukraine. China's quarantine authorities reportedly have also approved Thailand, Peru, and Laos as sources of corn imports used for processing.

Another analyst claims the effect of imported corn on the domestic market is relatively minor since the tariff rate quota system limits imports to 7.2 million metric tons.

State-owned enterprises are the predominant corn importers in China. During the first four months of 2013, SOEs have accounted for nearly all corn imported--over 1.4 million metric tons of corn. Other types of companies imported a little over 3000 metric tons combined. In 2010, SOEs accounted for two-thirds of imports. That year, private companies imported 35,000 mt while SOEs imported over 1 million metric tons. Foreign-invested companies imported 155,000 mt during 2010. (No data were reported for 2011 or 2012.)

China
corn imports by type of importer

2010

2013 (Jan-April)

Import volume

Share

Import volume

Share

Type of
enterprise

1000 tonnes

Percent

1000 tonnes

Percent

State-owned

1,069

67.9

1,444

99.7

Foreign-invested

155

9.8

*

*

Private and other

35

22.3

3

0.2

*= less than 1.

Source: China Customs Information Net.

The dominance of state owned enterprises reflects their preferential access to import quota and financing. SOEs get half of the 7.2-mmt tariff rate quota for corn each year while the rest is split among hundreds of private sector applicants. Small mills and traders are not even eligible to apply for import quota.

The report also reveals that nearly all imports come from the United States. During 2011-12, over 97 percent of China's corn imports came from the United States. During the first four months of 2013, 99.8 percent came from the U.S.

According to the report, China is pursuing a strategy of diversifying corn suppliers. In 2012, China approved Argentina as a source of corn imports, but the grain may be used for processing only. At the end of 2012, Ukraine was approved. The article describes the quick approval of Argentina as giving China an alternative to the United States for sourcing corn. China's quarantine authorities (AQSIQ) signed an initial agreement with Argentina in February 2012 and issued approvals to Argentine exporters only two months later. However, actual purchases from these "alternative" exporters have been small thus far. AQSIQ says Peru and Laos may soon be approved as exporters of corn for processing use.

The reports says it is important to note that Argentina's corn is very similar to that of the United States--about 80 percent is genetically modified (GM). The report describes genetically modified corn as a continuing food safety "hidden danger." The report says that effects of GM corn on human health have thus far been inconclusive, but the report claims that "not a few" domestic and foreign tests have shown that GM foods are a "potential hazard" to animals. Despite having no conclusive evidence of harm, the report urges caution regarding imports of GMO corn.

The United States may have a record corn crop this year, a huge reversal of two years of tight supplies and high prices due to successive U.S. droughts. The prospect of cheap U.S. corn plus weak demand in China and widespread quality problems with Chinese corn are putting downward pressure on Chinese corn prices.

As U.S. corn prices fall in anticipation of a big harvest, imports are becoming attractive to Chinese buyers. According to the cngrain.com weekly report on port corn prices, the price of U.S. corn reaching ports in southern China (the blue line in the chart below) is now 489 yuan/mt less than the domestic corn price in Guangdong Province.

The calculation is based on August 2 quotes of $224/metric ton of U.S. no. 2 corn at Gulf ports for September delivery. That's RMB 1385/mt in Chinese currency, and RMB 1991/mt on arrival in China plus taxes. The price was RMB 919/mt lower than a year ago when U.S. prices were at very high levels.

There is downward pressure on Chinese corn prices. According to an August 7 Yumi.com.cn report, corn at Guangdong ports was trading at RMB 2450-2470 /mt. Supplies of domestic corn arriving at the ports are plentiful, but there are quality problems due to "high temperature and abundant rain." Traders are eager to sell.

In Hunan Province, the new corn crop is coming on the market. Traders there tell yumi.com.cn the amount of newly harvested corn is small and there are some mold problems. Buyers are reportedly cautious in their purchases.

The price is RMB 2460-2500 /mt in Zaozhuang, Shandong Province, and is weakening. In Shandong's Shouguang market, the corn price is RMB 2430 /mt, down RMB 14 from the previous week. Traders there are expecting price declines and are eager to sell. Plus downstream demand from processors is said to be poor. In Handan, Hebei Province, hot weather is causing corn with high moisture to mold and traders there are also eager to sell. Prices there are also under downward pressure.

Tuesday, August 6, 2013

On August 8, 2013, Chinese authorities plan to auction 500,000 metric tons of northeastern soybean reserves. The soybean stockpiling plans for each season and the results of the auctions are regularly announced, but there are no complete official statistics.

Purchases are not always reported precisely and the microblogger has reported unofficial estimates for most years. The government also imported 2.5-3.5 mmt of soybeans to add to reserves in 2012--the microblogger estimates the total at 3.18 mmt. Auction sales are reported on a web site (the volume actually sold often is much less than the amount offered). During 2010, authorities held special sales of more than 2.6 mmt of soybeans to a handful of processing companies at a discount price of 3500 yuan. They held 25 auctions during 2012 which reportedly sold 3.758 mmt of reserve soybeans.

Cumulative purchases of soybeans from 2008 to July 2013 totaled 19.8 mmt, but only 8.5 mmt were sold. Purchases exceeded sales by 11.3 mmt. This is consistent with a report in Futures Daily that soybean reserves totaled 12 mmt in September 2012. It's also very close to USDA's current estimate of 2012/13 ending stocks of 11.6 mmt.

This level of soybean reserves is about 90 percent of China's annual soybean production, but only 15 percent of its consumption. The table above indicates that additions of imported soybeans replaced most of the reserves sold into the market over the past year.